Probe targets Google executive

SEC inquiry stems from former role at e-learning firm

By Robert Weisman, Globe Staff | July 30, 2004

As founders and executives wind up a road show designed to convince investors that Google Inc. is an Internet company for the new millennium, Google's general counsel has been ensnared in an accounting investigation reminiscent of the dot-com era.

David C. Drummond, Google's vice president for corporate development, secretary, and general counsel, was previously chief financial officer at an e-learning firm called SmartForce PLC. After a New Hampshire company, SkillSoft Corp., bought SmartForce in late 2002, SkillSoft was forced to restate three and a half years of financial data, much of it dating back to when Drummond was chief financial officer. SkillSoft recently settled for $30.5 million a class-action shareholder suit related to the financial restatements.

Now the Boston office of the Securities and Exchange Commission has advised Drummond that he faces potential civil fraud charges focused on his financial stewardship at SmartForce. The disclosure, though with few details, was made by Google in federal filings related to its IPO this week.

Federal investigators declined to discuss the charges they are preparing to recommend, but the document filed by Google said they involve ''disclosure and accounting issues relating to SmartForce's financial statements." The class-action suit, settled in March, cited false and misleading financial reports about SmartForce's revenues and earnings from 1999 through the first half of 2002.

Specifically, the suit alleged that SmartForce improperly booked $113 million in revenue from multiyear contracts for sales of its training software and computer-based courseware in quarters when the deals were signed rather than incrementally as payments were received. The suit said SmartForce officers and directors, including Drummond, ''acted knowingly or in such a reckless manner as to constitute a fraud and deceit" upon shareholders.

Drummond, as chief financial officer, had been responsible for SmartForce's financial reports. He joined Google in February 2002, seven months before SmartForce's merger with SkillSoft of Nashua. Drummond, through a Google spokesman, declined to discuss the case.

The events don't involve Google, which has promised to be a model of financial integrity. Google's chief executive, Eric Schmidt, released a statement expressing ''utmost confidence" in Drummond. Still, the SEC probe is casting a shadow over the Web search provider as it readies what is certain to be the most closely watched initial public offering in years. Google is looking to raise as much as $3.3 billion in the stock sale, expected next month, which would leave the Mountain View, Calif., company with a market value of as much as $36 billion.

The federal inquiry has proceeded over the past year and a half, and the SEC staff notified Drummond on July 20 that it plans to recommend that the five-member commission bring a civil injunction against him alleging violation of securities laws, including antifraud laws, according to Google's filing. Drummond is preparing a so-called Wells submission spelling out why he thinks an action should not be brought against him.

Google founders Sergey Brin and Larry Page have taken pains to stress they are committed to running an unconventional and ethical company. Their letter to prospective shareholders on April 29 was marked by a tone of quirky idealism.

''In our opinion," Brin and Page wrote, ''outside pressures too often tempt companies to sacrifice long term opportunities to meet quarterly market expectations. Sometimes this pressure has caused companies to manipulate financial results in order to 'make their quarter.' In Warren Buffett's words, We won't 'smooth' quarterly or annual results: If earnings figures are lumpy when they reach headquarters, they will be lumpy when they reach you."

The warning of a possible civil injunction against Drummond, a former partner in a prominent Silicon Valley law firm, creates a predicament for Google, said Nell Minow, a corporate governance specialist at the Corporate Library research firm in Washington.

''Certainly it's a problem for Google," Minow said. ''While I can understand their impulse to quickly say they support him, the more prudent tack would be to convene a special committee of their board to look into the matter. They should examine what his culpability might be, and what the impact on the company might be."

Haim Mendelson, e-commerce and management professor at the Stanford Graduate School of Business, said the SEC has been clamping down in recent years on businesses that book revenues when they disclose a sale rather than when they take in money, a common practice during the dot-com era. Companies ranging from WorldCom Inc. of Jackson, Miss., to MicroStrategy Inc. of McLean, Va., to Enterasys Networks Inc. of Andover, have been caught in the revenue-recognition dragnet and reached settlements with the SEC.

Mendelson, however, said he doubted the investigation into Drummond's financial reporting at SmartForce would hurt Google's IPO. ''It's a problem for Google, but it's more an embarrassment than a real issue," he said. ''It implies nothing with respect to Google's business."

Drummond had worked in the Redwood City, Calif., office of SmartForce, an Irish company that, six months after his departure, merged with the smaller SkillSoft on Sept. 6, 2002, in a deal valued at $564 million. SmartForce was the legal acquirer, but SkillSoft became the acquiring company for accounting purposes. Just over two months after the merger took effect, SkillSoft said it would restate its revenues for 1999 through the middle of 2002 to address accounting issues.

SkillSoft's disclosure resulted in five class-action lawsuits on behalf of shareholders against the company, its auditor, and 13 officers and directors, including Drummond. The cases were consolidated, and all the parties except the auditors, the Irish and US arms of the Ernst & Young accounting firm, reached a $30.5 million settlement in March that will be brought before a judge for approval in September. The case against Ernst & Young, which is scheduled to answer the charges this year, continues in US District Court in New Hampshire.

In his statement, Google's chief executive Schmidt said: ''We have the utmost confidence in David's integrity, as well as his abilities as a Google executive. We do not expect that this matter will have any bearing on Google, Google's IPO, or David Drummond's performance as vice president, corporate development and general counsel." A company spokesman, David Krane, said Schmidt would not elaborate.

Drummond was introduced to Google in 1998 when he was a partner in the corporate transactions group at Wilson Sonsini Goodrich & Rosati, a Silicon Valley law firm specializing in high-tech mergers and acquisitions. Working as Google's outside counsel, Drummond helped Brin and Page incorporate the company and secure venture capital.

Drummond now works with the management team to evaluate strategic partnerships and mergers, in addition to serving as general counsel, according to his biography on Google's website. Drummond's biography lists no background in finance or accounting. When he served as chief financial officer at SmartForce, its chief executive, Gregory M. Priest, was another ex-Wilson Sonsini partner.

Thomas J. McDonald, the current SkillSoft chief financial officer and executive vice president of operations in Nashua, said the surviving company continues as one of the nation's leading e-learning businesses with a senior management team that today includes only one former SmartForce executive, overseeing its Irish operations. McDonald said SEC investigators have talked to company officials, but no one at SkillSoft has been charged in connection with the investigation.